Booz Allen Hamilton Holding Corporation (BAH) Earnings Call Transcript & Summary

Good afternoon. Welcome back to the JPMorgan Industrials Conference for 2022. And we are very grateful to have with us this afternoon Booz Allen, and we have CFO, Lloyd Howell, who is here, and we have Laura Adams, Controller. We're going to have a little discussion here in a moment. I think Laura, I'll kick it off with you to tell us about forward-looking statements.

All right. Good morning or good afternoon, everyone. Before we get started, just want to keep in mind that some of the items we will discuss today are forward-looking statements, which may relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from forecasted results discussed in our filings with the SEC. All forward-looking statements are expressly qualified in their entirety by the foregoing cautionary statements and speak only as of the date made. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Back to you, Seth.

Cool. Thanks very much, and thank you guys for coming. Well, maybe we'll start off just with some big picture commentary. Maybe you can tell folks about what Booz Allen does, what distinguishes it from peers in the federal IT space and kind of how you see the market evolving?

Sure. We've got a pretty rich history over 108 years in existence, originally starting as a general management strategy consulting firm. Our first sort of federal experience happened in World War II, and one of our founders then consulted the Secretary of Navy during -- as they were thinking about operations in the Pacific. Since then, we have steadily focused on the federal market. 47% of our business is tied to defense, 30% to the civilian federal agencies and the balance on the intel community. We have a small, what we call, global commercial business that accounts for about 2% to 3% of revenue. What do we offer? We offer high-tech solutions in the areas of cybersecurity, system software development, data analytics, engineering and science. And we have over 30,000 employees, 70% of which hold a clearance of some level and are principally -- are headquartered in McLean, Virginia. And about half of our population is spread throughout the United States and the other half is concentrated in the D.C. metropolitan area.

Excellent. Maybe if we talk about the state of the market right now, I think most of us have observed in recent quarters, the certain slowness in terms of the level of activity within the federal government not so much in terms of there being demand or backlog growth or contracts awarded, but in terms of actually getting the work out on the part of the customer. Maybe you could talk about what you think are the most important drivers of that situation.

Yes. The last 2 years have been anything but typical from my experience, I've been at Booz Allen for, I guess, going into my 34th year. And so the last 2 years have been very atypical. And I think your commentary around slowness is spot on. From a demand signal perspective, the usual metrics we looked at are very strong. In terms of backlog, our backlog growing 19% year-over-year, book-to-bill trailing 12 months, 1.28x, win rates still holding. What is different, however, to your point, Seth, is that even with awarded work, there's just a slowness to ramping up and getting things going. And I think there are probably lots of opinions as to why. My sense in talking to our market leadership is that processes are there, they're being executed. But when we were all sort of elbow-to-elbow things happened at a quicker pace. This many years into working remotely or virtually, things just aren't as happened as quickly. And on top of that, some procurements have sort of slipped to the right a bit. They have not been canceled. But -- and then on top of all of that, the protest environment is alive and well. So that's just sort of stretches out the entirety of sort of getting things going and initiating work. I think the impact of COVID on the workforce is undeniable. Folks have been working virtually I think also very high levels of productivity. So downtime is, you just don't have those natural breaks that you had pre-pandemic. So we at Booz Allen have been very sensitive to that in terms of allowing folks to have breaks, focusing on mental health, things of that sort. But I think maybe we're on the other side of the pandemic, but people are definitely looking forward to different OPTEMPO and getting back to work physically. So all these dynamics have played out in a way that I think has contributed to things just moving at a slower pace and hopefully, now with budget in place and things beginning to open up, things will start to speed up.

Excellent. I was going to ask the degree to which you think having the omnibus for '22 can be kind of like a trigger for things to speed up versus the degree to which -- it's interesting what you said about COVID, because Booz Allen probably has a fair amount of flexibility and ways to think differently about how to make things work for people during this period. It's harder to do that in the federal government, just given the rules and the size of the acquisition core and everything. And so do you kind of need the customer to be back to a sort of normal pace of work? And if that's the case, I imagine that's something that's a little bit longer process.

Yes. 70% of our folks are at a client site. And so clearly, the pace at which the government begins to open up, will go a long way, so we're dictating when we get back to sort of being side-by-side physically with clients, I think all that's going to take some time to play out. In many ways, going into the pandemic is a lot easier than coming out. So you sort of flip the switch and everyone really went certainly at Booz Allen into a virtual state. But coming out of it is probably going to take a little bit of time. Each of our clients have their own protocols that they're working through. They're considering lots of different dimensions in terms of safety and protocols and engagement and have basically articulated they're expecting it to sort of be a gradual buildup to 100%, whatever that ultimately means. What we're doing is we're staying close to our clients, both the technical and the procurement side to make sure that we're ready to go when they are. And we're also offering assistance, whether it's PPE or any other things that we can do to be good corporate citizens to kind of facilitate that transition back to being together. And it will vary, given our portfolio. Our intelligence community never stopped. So they continue to work from -- over the past 2 years in physical proximity to our clients. Defense, a mixture of that, but predominantly remote and then also our civilian agencies probably most replicate or mirror where we've been in terms of near virtual type of posture. So we'll see how it goes, but certainly, the desire to open up and get back is there, and we would support that.

Excellent. You talked a little bit about the order strength in terms of the book-to-bill and backlog growth over the past year. And when we look at the total backlog, obviously, it's up significantly. But how should we think about unfunded backlog versus funded backlog? And even though the backlog is much bigger than it's been historically, would you say that, that gives you more visibility into the next few quarters than you've had historically?

Yes. One way to respond to that is sort of a conversion. But the funded portion, it literally converts 100% of the time, short of a cancellation or some broader dynamic. Unfunded and priced options and looking at those 2 together convert 60% to 70% of the time. And what we look at internally is priced options as a leading indicator as to; A, the client satisfaction with Booz Allen; but also their confidence in terms of future tasking that they would like to turn on. And throughout the pandemic and certainly the CRs, we've seen our priced options percent really stay stable, which is a great positive indicator as to the client's intent to turn on those tasks as well as their satisfaction with Booz. So that's how we look at it. In any given quarter, the funded and the unfunded percentages are going to go up and down. So -- and that's really just a function of where we are in that overall time line of the procurement. And I was in a meeting earlier today, and the question was like, "Hey, why isn't Booz Allen's growth rate the same as your increase in your backlog?" And there are lots of reasons, timing, what the client does or doesn't turn on, you name it. But that priced option percent has held steady and that gives us a lot of confidence about what they would like to do in the future. Now again, assuming a sort of 60% to 70% conversion.

Right. Okay. And then I guess, we've talked a little bit about some of the impediments to revenue and to letting contracts. But if we just thought about kind of this upcoming quarter, if you could give us sort of an update on the March quarter and whether you're seeing the kind of sequential sales improvement that you talked about?

Yes. So we updated our guidance at the end of Q3. And at the top line, brought down the guidance to be between 5.7% and 7.2% at the top line. And what we're seeing is still strength in the sort of demand signals. So we're still seeing strong capture rates, the dialogues with our current and prospective clients is still robust. And now that the budget cloudiness is starting to clear up a sense that we're looking into a pretty active procurement season certainly through the end of the government fiscal year. And that's good. It's good news, I think, for the sector, good news for Booz Allen, given our strong relationships and the things that we've been engaging clients on going forward. I think if you follow the bouncing ball as travel begins to pick up and whatnot, we would expect to see the sort of billable expenses component, move sort of in that 29% to 31% range for us. Empty calories for us, but still would contribute to the gross revenue line. We're principally focused on revenue ex billables, and that really is driven in large part by our ability to onboard the talent. Very competitive labor market, pre-pandemic as well as in the midst of it. So we would expect that not much is going to change or get any easier, but we're encouraged by our improvement that we've seen. I think in Q3, we were up organically 3.6% and then overall, 6.8%. So beginning to bring in the talent especially in hard-to-find skill sets, and that really is the strongest indicator of our ability to kind of translate and convert the strong backlog growth that we've had.

Okay. Yes, do you expect to add the number of folks that you were targeting for the March quarter, kind of like a very defined question. But then also bigger picture, there's a lot of change in the workforce, particularly for people with specialized technical skills. A lot of them don't necessarily want to be in the office or want to have a certain amount of flexibility, which doesn't -- which working with a government customer doesn't always lend itself to that. So I guess, how have you dealt with that challenge as a company?

Yes, it's interesting. Pre-pandemic, we were talking to a variety of clients about the concept of remote delivery and to your point, probably not making as much progress as we had hoped, in large part because our clients are just used to seeing their contractors outside their door and sort of the physical nature of it. And along comes of pandemic and sort of throws all the cards up in the air and quite frankly, an appreciation that folks can be highly productive, can provide support remotely. And we've seen that play out across our entirety of our business. So now we're having discussions that how can we retain the best aspects of what happened over the past 2 years. And where we do need to come together just be more, I don't know, precise or pragmatic about why? And if folks are going to travel or sit in rush hour traffic, what's the return on that? And I'd say across our client base, folks are much more open to doing that. And let's face it. Our clients aren't sort of this monolithic single thing. So we're going to have variations in degrees of comfort with whatever the delivery model is going to look like. But clearly, folks are more open to remote delivery, and we're going to be right there with them and trying to provide that. I think when it comes to the quarterly performance, it is tracking to how we guided. We will be bringing on the right number of folks to achieve those results. So we are seeing progress on the headcount front, and we would expect that momentum to continue to build going into our next fiscal year.

Right. As we look at just the progression of revenue going into fiscal '23 with the CR done and potentially some more contracting activity and the comps that you have in the first part of the year, do you see potential for growth in '23 to exceed the 3-year target that you've given?

Over the past 2 years, I think anything is possible. But at this point, our long-term guidance of sort of 5% to 8%, I think is a good starting point as we sort of step into the updated investment thesis. The factors that will contribute to that, as I mentioned, will be our ability to onboard the talent to convert the strong backlog that we have. We've got a fair amount of go-get space across our markets, and we feel good about our positioning and the relationships that will allow us to kind of capture that. It also assumes that our win rates for recompetes remains at about 90% and for new work low 60%. So all of that is sort of factored into it as well. And clearly, having a budget in place sort of helps across the board. Clients that had been a bit hesitant, given the budget uncertainty, that sort of frees them up to do what they'd like to do and obligating the money before the end of the fiscal year has always been a dynamic that we would expect to see this year.

Okay. One of the first things you mentioned when you talked about Booz and what the company does is cyber. So if you could talk a little bit about the level of activity in cyber. I think sometimes it's hard for those of us on the outside to: A, to get our arms around what it means, because kind of everybody says that they're involved in cyber; B, to think about, it seems kind of strange that across this whole space, there's been this kind of period of a little bit slower growth when you think the demand for cyber. I mean right now, I'd imagine the demand is increasing, given the increased tension with Russia. But we could have looked back a year ago or more at the SolarWinds hack and thought, okay, maybe that is going to drive more cyber demand. What's a good way for people on the outside to kind of think about the cyber market and the role that Booz Allen place?

Yes. So you're absolutely right, Seth. Everyone says they do cyber and let's assume that they do. What Booz Allen does is if you look at cyber as a stack, top of which is sort of strategic guidance or an assessment, working your way down through penetration testing, hygiene, standup of fusion centers, when there's an incident, incident response, governance, policies, organizational design, tool inventory assessment and architecting, what makes sense for a client, given their budget and/or their threat environment, monitoring services, all are a part of what I would say is sort of the top 1/3 of that stack. And that sort of Booz Allen's sweet spot. Now today, cyber is, in many ways, just table stakes for anything that we do. I can't think of any procurements where there isn't a cyber tasking. So we just take it as a necessary ingredient and you're right to play and you're right to compete. If we step up a level about 8 years ago, I would say that about 1/3 of our capabilities were in the sort of high-tech solution area. Today, it's about 2/3. So we have migrated our workforce and their skill sets during that time and cyber has been an important ingredient in that. But again, really focusing on the top 1/3 of the stack. And I think across the federal market, many of our clients see us in that light. So there are plenty of other vendors that when it gets down to the hardware things of that sort, but we'd like to see ourselves on speed dial for the top 1/3.

Excellent. That's very helpful. To drill in on one particular cyber item. I think there's a contract. I'm not sure of the name of it, but there's a contract that you guys have highlighted a couple of times on earnings calls where it's just a question of getting the money moving again. Have you started to see some progress there? Or do you think that having a budget will open it up?

We have seen progress starting with appointees getting through the confirmation process and getting slotted hand-in-hand with that. The money is starting to get set aside to get it back up to pre-pandemic run rates. All has been moving in that direction. I think with a budget in place, that will only accelerate to your previous point in light of some of the major incidents that are out there. This is like in the forefront of many of our clients' minds, particularly in the civilian federal market. So getting the support that they need, addressing what the threat environment is, which is also not going to get any easier is really top of mind.

Okay. Very good. Thinking about it another piece of the revenue pie, intelligent sales this year are trending below prior years, I think a little less than 20% of total sales. How do you think about a recovery in growth in this end market?

Yes. We, I think for the past 2 years, have been in sort of a rebuild mode in our national security market. We have 3 accounts that make up that market, national agencies, what we call cyber and then defense, military intelligence. And national agencies has probably returned to growth the quickest in large part because of our ability to work with our clients to bring on people, awaiting clearance approval, where they are productive, they are utilized and at the point that they get through the background investigations or the poly and go into a more highly classified program, they've been able to contribute and grow the business. The cyber account, the way to think about that, it's really anchored by 2 or 3 large procurements. And basically, all of them were up for recompete. And because of some of the delays and things shifting to the right, those recompete RFPs weren't released until recently. So growth has sort of hampered a bit to sort of have been extended, which is great. But in terms of then getting to the growth, we needed the dynamics of the RFP process to kind of occur and now that's beginning to happen. What was really slowing down the aggregate business was our defense military intelligence account, which was really going through a pivot from what was largely staff augmentation program management work to now higher end sort of data analytics, cyber types of engagements, but we had to reposition and build the relationships to allow us to compete for that. So with new leadership, sort of a revitalized team, we've been able to do that. And for the past 2 quarters, we've seen modest growth, I think 0.8% in Q2 and then another 0.8% positive growth in Q3, so upward trend. And then we recently bought a company that is going to help across the board in that market, providing AI, cyber security, really high-end data analytics support, which will be a nice complement to what we've been able to do organically.

Well, is that EverWatch?

It is.

Okay. So that was this week. I've read a little bit about it, but we've been doing the conference. So I haven't gotten all the details, but now you're here in person. So you just told us a little bit, but anything you would add about the rationale behind the acquisition. I think the financial details probably weren't disclosed on that one. And so I guess the expectation would be that the -- any accretion or incremental inorganic revenue is probably small at the outset, but maybe you can help us set our expectations?

Yes. Starting with what is always governed our inorganic activity is that the opportunity has to be on strategy, which it is. We -- Horacio and I over the years have said, "Look, we're going to do M&A to accelerate our organic growth." And so this is taking what we already had underway and allowing us to accelerate more so into it. Number two, we have to feel that the company is a good cultural fit to facilitate integration and checkmark there as well. As we've gotten to know them and they've gotten to know us, we feel really good about our ability to achieve some of the synergies that underpin the financials, and their positioning both for current and future opportunities is really solid. So that was another attractive aspect to it. We did not disclose the financials. I will say to you today, it is in keeping with our sort of small to midsize commentary of companies that we're looking at. It is modestly accretive to our financials. But I'd put more emphasis on the strategic positioning and the fact that it's going to round out our capabilities in what is otherwise a very challenging labor market, finding folks at the right clearance levels. And so that also provides us with that as well. So this is in keeping with what we wanted to do overall with our national security business, and we're really excited about the prospects of closing in early May and having that play out for certainly in the next few years.

Excellent. And so this is something where you feel like with this addition, this will put you in a better position to win future procurements.

Yes. I mean the market has a few significant competitors. And so the stakes are typically pretty high on any one procurement. So for any one of us, the positioning around future procurements where it's really winner takes all for a number of years is important. And so the addition of them to the team in real tangible way has been a really, we feel, strengthen our positioning and to compete for some of these upcoming procurements in that space.

Right. I guess you mentioned in the cyber account within intelligence kind of 3 main contracts and having recompetes coming up on those 3. So, A, does this kind of -- this EverWatch kind of make you feel like it strengthens your hand in terms of retaining those contracts? And then maybe the second question is, if we think about the number of big contracts out there, chunky pieces of work that you'd want to have in your cyber account? Three, would represent roughly what proportion? And are there takeaways out there potentially for you as well?

Yes. I don't want to sort of start to quantify for a variety of reasons, like the list of which is our clients don't want me going on there -- down that path. But to your opening point, for sure, having them as part of the team does in their own right, they are well positioned. And I think being part of the Booz Allen family just sort of overall strengthens our position. I think this is a market where your intimacy to the mission requirements, your insights to the mission are critically important, because it's the one thing you do cyber, but there's just so much intuition that has to be applied when you're looking at adversaries, their behavior, threat environment and so on and so forth. So having them as part of the team just rounds up the overall team, and I think strengthens our positioning, just given the insights that we have with current programs and then also programs down the road. So this is an account that does -- is sort of anchored by larger procurements. They're lengthy in duration, and so highly contested as well. So we're looking to improve our odds and our chances, and having a company like that as a part of Booz Allen is going to help.

Do you expect all 3 of those recompetes to happen during fiscal '23?

No, they're staggered. I mean, they're all at different points in their life cycle. I just highlighted one that will be up, but the other 2 are -- won't be competed for quite some time.

Okay. Okay. Got it. Okay. Shifting maybe to profitability. It seems fairly -- you seem to be in a pretty good position to deliver on the margin guidance for this year, I think at least 11%. When we think about the main headwinds and tailwinds for next year, what would you call out?

Yes. I think some of the dynamics that have served as tailwinds over the last 2 years are going to start to shift. One of those is, as folks begin to travel, billable expenses pick up, what has now been a tailwind will certainly become a headwind. I do expect that our strong contract execution is sustainable and will be here for a while. And that's really code for, our market leadership is focused not only on the top line but the bottom line. So really going after high-tech work, which set the right financials is sort of the mindset, and I would expect that to continue. I would also expect the continuation of being able to bill for fee in the intel market now that the CARES Act is behind us. And I would expect that as Liberty continues to grow the percent of contract mix that's fixed price, we'll see a modest increase in that. And so all of those dynamics will be getting to shift a bit, but I think the underlying contribution as to why, we're now looking at about 11% for this year will still hold.

Right. Okay. Excellent. I guess if we think -- one of the things I wanted to ask about with regard to the margin is R&D. And at the Investor Day, you talked about doing more R&D, which seems quite sensible. But maybe if you can give us a sense of both the scale of that and what's coming as well as the main focus areas?

Yes. One of the dynamics that we've always done is sort of invest in emerging businesses or opportunities or initiatives that we think will meet future client demand. And one of the 2 areas that we highlighted at our October Investor Day was digital battlespace and global cyber. In both cases, there are contracts that, I would say, are consistent with each. We've had the benefit of listening to DoD seniors, and they talk about where they would like to take the department. So digital battlespace, we feel is very consistent with how they're thinking about the future and where we want to play in terms of bringing together emerging technologies in a more holistic way than what may be occurring now. So we're thinking through that very deliberately and investing initially and bringing on the right talent and then also looking at M&A opportunities that would be consistent with complementing our organic efforts. Cyber is, again, another area that we see no end in sight in terms of future demand, not the least of which is adversaries aren't going to hit the pause button anytime soon. And a need across even broader sections of the government that need to improve or step up in that area. And we want to be a partner with them to help in that regard. So it goes back to my commentary around the top 1/3 of the stack, which we certainly believe is relevant for what they need to do. And so our cyber platform efforts are really aimed at that. How do you get at a more broader kind of cut of the federal market? And then how do you bring the best of thinking from intel into civil where you can and defense and help clients across the board. So that's two of the areas that we're going to be investing in. And we have some on the horizon that we didn't highlight, but it's all part and parcel to catching the next wave of growth beyond FY '25.

Okay. Within the R&D bucket for the future, do you think about the option value items that you guys have called in out in the past?

We do. The option value initiatives were never really meant to be a sort of top line contributor in many ways because of the scale. They contributed to margin, and they also helped us to test a couple of different delivery models that we wondered whether they had merit. In the case of Recreation.gov, where we developed a reservation system for the Department of Agriculture, economically, we've seen better profitability as well as less of a dependence on a labor-driven model. So that has given us and opened up ideas about other things we could be developing. And now that is sort of launched the whole work stream, if you will, into that direction. District Defend, which is essentially securing mobile devices, did a pivot to really focus more so on the software side of things, and it's really dependent upon units sold, if you will. So the introduction of products, and I say products in quotes, but is again, testing out a different sort of delivery mechanism. And I think we learned a lot in terms of lessons learned, how to approach it. You're really thinking and talking to clients about a different sort of way to be productive, and that's been good for us. Directed Energy is really taking laser technology, putting it on smaller platforms. I know Booz Allen is not going into the weapons business, but the ability to explore and be seen as a thought leader in the eyes of our clients has really been really exciting for the people that have been on that team, to go through prototype testing, to really do cool things with laser technology. And then lastly, Modzy, which is really sort of more of a commercial application around AI, we spun out. And so in that case, how to monetize some early investment, how to present a different career pathing for our workforce have been the benefits in that. So those 4 initiatives alone, I think we've learned so much since we launched. We've got additional ideas in the hopper that are coming through. And so that really speaks to the generation of our IC, our IP, how to monetize that in lots of different ways. And I think we've learned a lot in a different way.

Very good. I want to make sure we touch on cash flow. We got about 2 minutes. So a couple of more questions, and make sure that we discuss cash flow a little bit. I mean, if we look at next year, top line margin, it seems like EBITDA should grow in fiscal '23. But then sort of below the EBITDA line, there's a couple of moving parts in terms of cash taxes or payroll tax reimbursements resulting from the CARES Act, differences in working capital. So what are the main moving pieces beyond EBITDA growth that we should be thinking about for free cash flow in 2023?

Yes. I mean I think -- and consistent with our investment thesis, having that sort of organic growth in the 5% to 8% range is going to contribute to our ability to generate cash. Historically, we've been a strong cash generator. We have had 2 quarters this year where it came in lighter really due to onetime events and we're seeing improvement in our fourth quarter, getting back to where we want to be. And I think that's going to continue going forward. We've focused on operating cash, but it's equivalent to about 100% conversion, and we would expect to be there. But just strong collections managed consistent with our payables is where we needed to be. We moved Laura to become our treasurer, and she's -- it is her job #1. And so under her leadership, I'm expecting us to have really consistent strong cash generation for years to come.

Okay. Yes. And so when you say 100% -- converting 100% of net income into cash from ops?

Correct.

Okay. Very good. We are inside of 30 seconds, but let's try and sneak one more in here. And I know there's just an acquisition announced this week, but I guess what have you done for me lately. It doesn't seem like a major acquisition. So what would be the -- and you did talk more at the Investor Day about pivoting to M&A in your capital deployment strategy. So what would be the appetite for more acquisitions over kind of the next 3 to 6 months? And what does the pipeline look like?

Yes. The pipeline is continuing to build. I would characterize it as small to midsized companies. I would say, it's a reflection of our business portfolio. So Liberty was sort of in our public health market. The most recent is in our intel market, but we've got other opportunities that are defense, are geographic in nature. And what I've said is on a net leverage basis, we're comfortable being between 3 and 3.5x. If a larger opportunity were to come along and it met our strategic and cultural objectives, we're definitely going to take a look. Does that sort of translate into stretching north of 3.5x? You never say never, but I'd say probably unlikely. We're really looking at fundamentally capability tuck-ins. And the way the pipeline is building out, it's very consistent with that.

Okay. Excellent. And with that, we've reached time. So thanks very much for being here. We really appreciate it.

Thank you.

Yes. We'll hear from you soon.